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It's Harder to Get a Mortgage, but That's a Good Thing

Source: 401(K) 2012.

Qualifying for a mortgage may soon become harder than it has ever been before.

After eight full months of debate, it appears that regulatory framework introduced earlier this year will come into effect by January 10, 2014, according to a new manual from the Consumer Financial Protection Bureau.

Here's what new lending standards mean for the real estate market.

Setting the bar
After January 2014, banks will have to meet certain criteria for mortgages they sell to investors, including Fannie Mae (NASDAQOTH: FNMA  ) and Freddie Mac (NASDAQOTH: FMCC  ) . The biggest change is a requirement that borrowers have a debt to income ratio of less than 43%.

The cap includes all household borrowing, from a mortgage to credit cards, automobile financing, and even student loans. To keep the numbers simple, someone who reports gross income of $10,000 per month must spend less than $4,300 on all debt payments and home-related expenses.

The median annual American household income in July was $52,113, leaving a full $1,867 per month for the median family to spend on debt servicing.

Thus, a debt-free household earning the median income could still afford to purchase a home worth more than $400,000 at current 30-year mortgage rates of right around 4.5%. That's no small home in much of the United States.

You can't have it all
Regulatory critics suggest tighter lending standards would slow first-time home sales and housing appreciation. They're probably right -- when people can afford only smaller loans, home prices tend to stagnate.

Of course, the opposite is also true. Loose lending standards send prices skyrocketing.

In 2005, two couples who earned only $6,800 per month were given the green light to purchase a $720,000 home requiring a monthly payment of $5,278. Being immigrant strawberry pickers, their incomes were tied to the most unpredictable of natural events -- weather. Alas, that didn't stop a combination of potential mortgage fraud and poor underwriting to allow them to buy a home at a price they obviously couldn't afford.

That story isn't the only one of mortgage excess. In 2005, approximately 20% of American mortgages were subprime, according to one Harvard University study. As millions of unqualified buyers bought homes, prices rocketed:

Source: Calculated Risk Blog.

Regulations great for banks and homeowners
New standards are good for all involved. Banks will now have clear-cut standards, which, if followed, would insulate them from legal risks. That's good news for companies like Bank of America (NYSE: BAC  ) and JPMorgan Chase  (NYSE: JPM  ) , which face billion-dollar legal challenges surrounding aggressive lending practices.

Likewise, the new requirements are good for homeowners and the economy at large. A firm requirement on how much borrowers can afford should allow for slow home price appreciation and limit the potential for bubbly home prices. 

Perhaps most importantly for home buyers, limited legal risks for banks and tighter lending standards may hold down the cost of a mortgage in a rising-rate environment. Banks currently build the cost of legal risk into mortgage rates. Tighter lending practices may put a damper on a hot housing market -- prices are up 12.4% in just one year.

Yes, it will be harder to qualify for a home. New limits will make real estate and banking boring again. After years of excitement, we should welcome boring, but profitable, banking and real estate sectors with open arms -- even at the cost of tighter lending policies. 

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Read/Post Comments (11) | Recommend This Article (5)

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  • Report this Comment On September 14, 2013, at 10:35 AM, Mogul2013 wrote:

    Good for who? Retirees won't be able to buy or possibly refinance. Young families will not be able to purchase without two jobs to meet the 43 percent rule. The housing market that positively drives the economy through job creation will stall. That has a domino effect on consumer goods which leads to anemic job growth if not outright negative growth rate.

    Congress will create exceptions to these arbitrary rules if not before they are implemented then certainly soon after the bad effects are obvious.

  • Report this Comment On September 14, 2013, at 10:41 AM, Broker2NotBroken wrote:

    I read this article last week S&P and it was checked out through "snoops". A client said this is bogus, and I would like further information regarding where you received this information from. I have a lot of clients, family and friends who would like the real scoop on this. I wouldn't doubt it if this did happen. There are an awful lot of foreclosures still occuring yet not being released back on the market, seems some lenders are bundling foreclosures and selling them to investor groups. Appreciate any confirmation you can give.

  • Report this Comment On September 14, 2013, at 10:55 AM, TMFValueMagnet wrote:

    Mogul2013 - A limit at 43% is hardly stringent. The median household can still afford a pretty expensive property given that rates are very, very low. I'd prefer slow economic growth to loose lending standards and double-digit growth. Slow but steady wins the race.

    Broker2NotBroken - See the CFPB guide in the article. Here's a link

  • Report this Comment On September 14, 2013, at 11:34 AM, HoosierNative wrote:

    If this stops those lending banks from giving to anyone and selling off to Fannnie/Freddie which would then absorb the loss, then I am all for it.

  • Report this Comment On September 14, 2013, at 12:08 PM, wmurray003 wrote:

    Good. This will allow the housing market to "slowly" retain more value... we're talking less foreclosures/shortsales etc. It's not a good thing for everyone, but it is a good thing for the ones who are playing the game fairly and not biting off more than they can chew.

  • Report this Comment On September 14, 2013, at 12:37 PM, edugal wrote:

    Though some of your comments on the new mortgage rules are right, they actually show clear lack of knowledge and understanding of the CFPB regz. For starters, the 43% rule does NOT apply to Fannie/Freddie loans! The rules are a tangle of vague, general language that scares banks out of lending because of horrendous legal ramification. Not to delve into the whole thing (it is longggg), the end result is the unintended consequences of making loans more expensive and less competitive- higher rates and higher costs are coming, and all borrowers will suffer as a result. Regulation is needed, but this is a dumb way of going about it.

  • Report this Comment On September 14, 2013, at 3:15 PM, TMFValueMagnet wrote:

    Edugal - Banks can and could write what they want, but again, it comes back to the consequences. You can drive drunk, too, if you look at it that way.

    The message to banks is clear: Follow these standards or risk legal problems in the future. Given the huge pending lawsuits making headlines practically everyday, banks will likely follow the standard as they have been.

    HoosierNative - Fannie and Freddie have always been a way to dump risk. The cost to do so is going up, however. See this article on guarantee fees:

  • Report this Comment On September 14, 2013, at 4:36 PM, drgill2 wrote:

    Hmm, the couple made $6,800 a month picking strawberries and bought a $720,000 home? I find that rather difficult to believe.

  • Report this Comment On September 15, 2013, at 5:43 PM, promommyfool wrote:

    Drgill2 - I agree. There are alot of fuzzies in the idea senerio proported in the strawberry pickers example. The idea that they were qualified for a 720K loan is ludicrus. I remember the last time we bought a house. We had to use most of our downpayment money to pay off debts that disqualified us from getting a loan. The banks were fine with a small downpayment as long as we had almost no outstanding debts to pay along with our home loan.

  • Report this Comment On September 16, 2013, at 1:30 PM, pksmooth wrote:

    No pulitzer prize for you!

    Some errors in the article.

    Firstly, the housing expense of approximately $1800 per month does not include taxes, homeowners insurance, flood insurance and say a homeowners association. These escrows are part of a housing expense. Principal and interest are not the only variables that constitute a housing payment.

    In most markets you need to add an additional 500 to 900 for property taxes, homeowners insurance, homeowners association dues and the dreaded PMI in the even there is less than 20% down payment equity. Take these into consideration and we are now at one half that price point. 200K is where you are at. I am not making a judgement call here as 200K will likely be in line for a mortgage seeker earning 50K annually. What we miss here is that most folks do carry some amount of debt, whether it be an auto note, student loan or even a small balance on a credit card. Add an additional $300 per month in debt and we are now at $1500 maximum new housing debt. Again, in line with this kind of income, but certainly cannot purchase a 400K home, no way no how.

  • Report this Comment On September 16, 2013, at 11:28 PM, pawncracker wrote:

    In the article he said "two couples" earning $6800 a month. That's $1700.00 a month per person. Still hard to believe strawberry pickers would earn that much. They are some of the most exploited workers out there.

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